IN THE INCOME TAX APPELLATE TRIBUNAL HYDERABAD BENCH A', HYDERABAD

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1 IN THE INCOME TAX APPELLATE TRIBUNAL HYDERABAD BENCH A', HYDERABAD BEFORE SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER AND SMT. ASHA VIJAYARAGHAVAN, JUDICIAL MEMBER ITA No. 918/Hyd/2010 Assessment Year: Asst. Director of Incometax (International Taxation) I, Hyderabad Appellant vs., Hyderabad. PAN AAACB8231F Respondent Revenue by: Sri P. Soma Sekhar Reddy Assessee by: Sri P. Murali Mohan Rao Date of hearing: 28/11/2013 Date of pronouncement: 27/01/2014 PER CHANDRA POOJARI, AM: O R D E R This appeal preferred by the Revenue is directed against the order of the CIT(A)-VI, Hyderabad dated 25/03/2010 for the assessment year wherein the Revenue has raised the following grounds of appeal: 1. The Ld. CIT(A) erred in law and on the facts of the case. 2. The learned CIT(A) has erred in not appreciating the full facts of the case, nor has brought out on record the full facts from the assessee regarding non-submission of any agreement or delayed submission of the supplementary agreements. 3 The ld. CIT(A) has erred in facts and law by holding that software and source code are two separate items of transactions whereas the source code is highly critical to any software having higher intrinsic value compared to a software application as a whole. 4. The ld. CIT(A) has erred in laws treating the transaction as business income, whereas the transaction is actually in the nature of royalties and fees for technical services.

2 2 5. The ld. CIT(A) has erred in laws by holding the royalties in Article 12 of DTAA (India and Singapore) or section 9 of IT Act as fees for technical services does not apply. 2. Briefly the facts of the case are that the assessee is a company engaged in the business of providing enterprise solutions based on smart cards, bar coding, biometrics etc. A survey u/s 133A was conducted on 11/02/2009 in the business premises of the assessee by the Department to verify the TDS payments made by the assessee. It was noticed by the Assessing Officer that an amount of USD 2,00,57,969 (INR 97,41,67,421/-) and USD 19,82,454 (INR 9,67,88,361/-) had been accounted as payable/paid to Gamma Machinery and Equipments PTE Ltd., Singapore (GAMMA) and Intra Asia Trading Pte Ltd., Singapure (Intra) for the purpose of complete source code for contact/contact less smart cards operating systems for transport application, conforming to National Informatics Centre, Govt of India standards with Intellectual Property Rights along with necessary development, testing, soft and hard masking process instructions and user documentation for various companies IC Modules/Micro controller range of various EEPROM sizes. The ADIT, after ascertaining the details, finally concluded that the above amounts payable/paid by the assessee company is liable for TDS u/s 195 of the IT Act and accordingly worked out the liability u/s 201(1) and interest u/s 201(1A). The details of amounts paid to the foreign companies and TDS liability u/s 201(1) and interest u/s 201(1A) determined by the ADIT were as under:- Name of the Payment grossed TDS Liability Interest u/s foreign company up (Rs.) u/s 201(1) 201(1A) Intra Asia Trading Pte Ltd., Singapore Gamma Machinery & Equipments Pte Ltd., Singapore Total

3 3 Aggrieved, the assessee carried the matter in appeal before the CIT(A). 3. Before the CIT(A), it was submitted that the business of the assessee is covered by articles 7 and 5 of DTAAs and under article 7 of the DTAAs, income earned by a non-resident in India under the head business can be taxed in India only if the non-resident has a permanent establishment (PE) in India. Permanent establishment itself is defined in article 7, and it means a permanent branch or a permanent office located in India. If the business is carried on through employees and if those employees stay in India for less than 183 days in the cases of Singapore there will be non PE in India and the corresponding business profit of the non-resident becomes nontaxable. 3.1 Further, it was submitted that none of the two foreign parties has a PE situated in India, since none of them have a branch or an office in India and, therefore, in the absence of a PE there can be no taxable business profit arising in India for any of the above foreign parties, in view of Article 7 of each of the DTAAs. It was also submitted that though the services rendered by the Singapore individual must be considered as independent personal services, as an alternative submission, it should be considered under the head business. Since there is no PE for any of these parties in India, the business income is exempt from taxation under article 7 read with article Without prejudice to the above submissions, it was submitted that the rates of tax adopted by the Assessing Officer are not in accordance with the DTAA rates. 3.3 Further, it was submitted that the applications of smart cards in various field such as banks and social segment is universal and

4 4 software relating to the application are developed by the software developers matching the requirement and made available to the buyers as tailor-made-off shelf products. Thus, the acquisition/purchase of the set is a product along with the attached IP rights distinguished clearly and paid accordingly and accounted accordingly. It was submitted that the assessee is under the impression that the payments made squarely fall under goods. It was finally submitted that as there is no income deemed to be accrued or arise in India out of the above and it is being business profit for the non-resident company and as there is no permanent establishment exist in India, the provisions of section 195 and section 201 of the IT Act are not applicable to the assessee company and tax deduction does not arise. The assessee relied on various case laws before the CIT(A) which were extracted by the CIT(A) at pages 15 to 21 of the impugned order. 4. The CIT(A) after considering the submissions of the assessee as well as the submissions of the ADIT during appellate proceedings, discussed the issue elaborately with various case laws from paras 6 to 7 spread over pages 21 to 55 and held that the amounts paid to Intra Asia Trading Pvt. Ltd., Singapure and Gamma Machinery and Equipments Pte Ltd., Singapore, towards purchase of software do not attract TDS. The concluding paras of CIT(A) are as under: 8.0 On the factual findings of the ADIT in the facts and circumstances of the case, the AR strongly objected to the same and contended that the appellant is not liable to deduct taxes u/s 195(1) of the Act. On a careful perusal of the order u/s 201(1) of the ADIT and the supplementary agreements entered into by the parties I am of the considered opinion that the ADIT is not entirely correct in his approach. In the case of TATA Consultancy Services Vs. State of AP [2004] 271 ITR 401 9SC), the Hon ble Supreme Court observed that the intellectual property incorporated on media for the purpose of transfer should be considered as sale of good under the APGST Act. In the normal circumstances, cases decided under sales tax law are not applicable to income tax law. However, the aforesaid case law is relied only for the limited proposition that intellectual property incorporated on media for the purpose of

5 5 transfer should be considered as sale of goods. In the present case, the ADIT having accepted that the foreign companies transferred the software to the appellant in their capacity as trading agencies and intermediaries, it cannot be said that they have parted with their exclusive rights entitling them with royalty. It cannot also be said that the same would constitute fees for technical services paid to the foreign companies as consideration for rendering of technical services associated with the source code for smart card operating system and related technical services for the same reason that the foreign companies involved in the transaction merely transferred the stock in trade held by them in their regular course of business without rendering any technical services. 8.1 Thus, the appellant as well as the foreign companies acted on the agreements entered into by them. The appellant company made the outright purchase on their own account and those transactions were supported by proper documents such as invoices, shipping documents etc. Therefore I am of the view that improper analysation of the facts by the ADIT(IT) led him to an improper conclusion that in respect of a package transaction which is now under consideration the entire amount has to be considered either as royalty or fees for technical services. Thus, the ADIT(IT) missed the track from sum and substance of the transaction involving purchase of products under different agreements. In view of that, the supplementary agreement alone will make the foreign companies liable to tax for the purpose of Indian Income Ta Act, 1961 which consequently make the appellant liable u/s 195(1) for the payment made by it towards Intellectual Property Rights Source Code. On the other hand, payments made for purchase of the software itself being covered as the sale of goods and hence the same cannot be subject to tax for the purchase of software which is outside the purview of taxation of withholding tax. 8.2 In earlier part of this order, I have already held that the amount involved in this transaction constitute business income of the foreign companies and not liable for deduction of tax at source u/s 195(1) of the IT Act and since the payments involved were identified as buiness income of the foreign companies the question of giving a finding regarding rate of tax applicable for these transactions does not arise. 8.3 Considering the facts and circumstances of the case, the transaction under the consideration effected by the appellant should be considered as business transaction as envisaged under Article 7 of Ind-Singapore DTAA. Since the appellant has brought a readymade off the shelf computer programme which does not grant any right to utilize the copy right of the computer programme, I am of the view that the payments made by the

6 6 appellant company cannot be held as royalties coming into the ambit of Article 12 of DTAA or fee for technical services u/s 9(1)(vii) of IT Act and accordingly no tax need to be deducted u/s 195 of the IT Act. 9. In view of the above, I hold that the amounts paid to Infra Asia Trading Pvt. Ltd., Singapore and Gamma Machinery and Equipments Pte Ltd., Singapore towards purchase of software does not attract TDS or withholding tax on the following amounts: 1. Payments to Gamma Machinery Rs. 97,41,67,421 [$ ] 2. Payment to Infra Asia Trading - Rs. 9,67,88,361 [$ ] 5. Aggrieved, the revenue is in appeal before us. 6. Before us, the learned DR submitted that the consideration paid by the assessee company for the source code(s) of the smart card operating systems is characterised as royalties as per the DTAA, as the consideration is for the use or right to use the secret formula or process and also for information concerning industrial, commercial or scientific experience. It was further submitted that the said consideration also falls within the definition of fees for technical services as defined in the treaty. It was also submitted that as per paras 1 and 2 of the Article 12, the royalties or fees for technical services arising in a contracting state (India) may also be taxed in the contracting state in which they arise according to the laws of that state, and provided if the beneficial owner of the royalties is a resident of the other contracting state (Singapore), the tax so charged shall not exceed 10 per cent of the gross amount of the royalties. 6.1 The DR submitted that section 195 of the IT Act, 1961 puts responsibility on the person responsible (Batronics or its Principal officer) for paying to a non-resident (Intra/Gamma), to deduct tax on the sum chargeable to tax. Further it was submitted that from the above provisions, it is clear that the deductor-assessee was very much required to make deduction of tax at source while making payment on account of the transactions under consideration. It was

7 7 contended that since the assessee had not made any such deduction of tax while making the remittance to the non-resident and as such the deductor assessee is liable for the consequences of its failure to deduct tax and, therefore, the Assessing Officer has rightly made the addition u/s 201(1) and 201(1A) of the Action. 7. On the other hand, the learned counsel for the assessee has filed detailed written submissions, which are as under: a) The provisions of Section 195 of the Income Tax Act, 1961 are not applicable in the respondent's case. As submitted in the foregoing paras, the AO has raised the demand in dispute by invoking the provisions of Sections 195 of the Income Tax Act, In this connection, it is submitted that the very provisions of Section 195 are not applicable to the assessee herein for the impugned payments are made to non-resident foreign companies which are not covered by the provisions of Section 195 of the I.T. Act, Ground was taken by the assessee herein before the 1 st appellate authority on this issue and the assessee herein relied on the order of the CIT (Appeals) in Para Nos. 7.2 to 9 at page Nos. 37 to 57 of his order. b) The payments under consideration are "Business Incomes" of the Non- Resident Companies. The AR submitted that the provisions of Section 195 of the Act are not applicable to the assessee herein, since the payments under consideration constituted "Business Income" of the non- resident companies. This fact is very much accepted by the AO vide clause (5) of Para No.5 at Page Nos. 21 and 22 of his order. The relevant extract from the assessment order is as under: "5) the Company's argument that the payment under consideration constitute "business income" of the non

8 8 resident is valid, considering the fact that the non resident is in the business of trading in the 'unique source code items' held as stock in trade or in the business of rendering of services in the realm of software and related technology, as the case may be. As such the 'business income' of the non-resident recipient would be chargeable under the head 'profits and gains of business or profession' as per the Income Tax Act, The company also rightly observed that if there is no 'permanent establishment' (PE) in India for that non-resident, there will be no taxable income accruing in India as per Articles 7 and 5 of the DTAA. But a thorough reading of Article 7 gives the understanding that "where profits include items of income which are dealt with separately in other Articles of this Agreement, then the provisions of those Articles shall not be affected by the provisions of this Article" (para 7). In the instant case though the consideration for the source code for the smart card operating system constitutes 'business profit' of the nonresident, the same consideration can also be characterised as 'royalties' or 'fees for technical services', as the case may be. In such a situation, where the business income/profit of the non-resident include 'royalties' or 'fees for technical services', the taxability of these items of income shall be governed by the Article 12 of the DTAA with Singapore. This is in sync with the principle 'Generalia specialibus non-derogant' which lays down that 'general provisions' will not override the 'special provision'. In the case of the company, the provisions dealing with 'royalties' or 'fees for technical services' under the Act as well as DTAA are 'special provisions' and should be given effect to the extent of

9 9 its scope, leaving the general provision to control cases where specific provisions do not apply." While accepting that the impugned payments constitute the "Business income of the non-resident companies, the AO has taken a 'U' turn by observing that same consideration can also be characterised as "Royalties" or "Fees for technical services", as the case may be. This view of the AO is vague and baseless. There is no ambiguity in the statue in this regard. The application of the principle of 'Generalia Specialibus non-derogant' is mis-quoted in the assessee's case. Even if the second view taken by the AO were to be considered for argument sake, the AR submitted that if two reasonable constructions of a taxing provision are possible, that construction which favours the assessee must be adopted. This is well accepted rule of construction recognised by the Supreme Court in the case of CIT vs Vegetable Products Ltd (1973) 88 ITR 192 (SC). In this regard, the assessee herein, relied on the observation of the CIT (Appeal) in para Nos. 6.0, 6.1, 6.2, 6.3, 6.4, 6.5 and 6.6 at page numbers 21 to 26 of his order. c) There is no need to AO to traverse beyond Article No 7 of the DTAA between India and Singapore and examine the impugned transactions in the light of Article No 12 of the DTAA. The AR submitted that the assessee here in has acquired from the non-resident companies "a readymade off the shelf computer programme to be used in its business and that 'no right' has been granted to the assessee here in to utilize the copy right of the programme. Since in the impugned transactions, a computer programme called "Software" has been purchased, the consideration cannot be treated as, "Royalty". In support of this, the respondent here in has relied on the following case laws:

10 10 1. CIT Vs Neyveli Lignite Corporation Ltd [2000] 243 ITR 459 (Mad). 2. Sonata software Ltd Vs. Income Tax Officer [2006] 6 SOT 700 (Bang). 3. Mphasis BFL Ltd. Vs Income Tax Officer [2006] 9 SOT 756 (Bang). 4. Lucent Technologies Hindustan Ltd Vs. Income Tax Officer [2005] 92 ITO 366 (bang). The above mentioned case laws and the issue have been discussed by the CIT(Appeals) in para Nos. 6.6 to 6.8 at page Nos. 24 to 29 of his order. The assessee herein relies on the observations of the CIT(Appeals). d) AO's observations of failure on the part of the respondent here in to bring on record the original developer of the source code have no merit. The AR submitted that vide Para No at page No. 14 of his order, the AO observed, among other things, that the respondent here in having obtained the "Source Code(s)" from INTRA/GAMMA (the non resident company) a mere trading house, which is neither a developer nor a business house expertised in development of software/computer programme, failed to bring on record the original developer, who developed the 'Source Code' for operating systems and that it was unable to bring on record on what terms and conditions the "Source Code" was produced by INTRA/GAMMA from the original developer /owner of the "Source Code". In this connection, the AR submitted that the assessee here in has no obligation to bring on record either the original owner or the terms and conditions for producing the source code to the non-resident companies. In this regard, the AR relies on the observations of the CIT (Appeals) vide para Nos. 6.9 at pages 28 and 29 of his order.

11 11 e) "Software" and "Source code" are two separate items of transaction The AR submitted that the observation of the AO that "Software" and "Source code" are not two separate items, the AO has not taken into consideration the supplementary agreements filed before him during the course of assessment proceedings. The supplementary agreements clearly show the bifurcation of the payments towards "Software" and the "Source code". The reasons for rejecting the plea of the assessee herein on the bifurcation of the payments as given by the AO have no basis. Merely because there is no bifurcation shown in the invoices and there is no reference to the bifurcation in the statements of the key managerial/technical personnel, the bifurcation in the nature of payments cannot be denied especially in view of the Agreements and Supplementary agreements existing in support of the bifurcation. Also, merely because the assessee herein failed to make available to the Department any communication ( , etc) on the price negotiated, it cannot be inferred that there is no bifurcation in the payments. The AR submitted the agreement copies and supplementary agreement copies were furnished before the AO during the course of assessment proceedings. The observation of the AO in Para No at page 13 of his order that the fact that the" Supplementary Agreement" was signed and agreed by the contracting parties makes no difference, given the fact that the delivery of the "Unique Source Code set(s)" and consideration thereof were settled between the parties and as such there was no purpose for the parties to revise their agreement to avoid tax as the said transaction was being scrutinized by the department has no basis. With regard to the observations of the AO in para no.4.7 at page

12 12 no.1 0 of the impugned order, the AR submitted that the statements of the representative of the respondent company herein and the existence of the supplementary agreements have already been considered by the Ld. CIT(Appeals) in his appellate order. In this regard, the assessee herein relies on the observations of the CIT(Appeals) in para Nos and 6.11 at page Nos. 29 to 33 of his order. (f) Decision of Karnataka High Court in the case of CIT(lntI.Taxation) vs. Samsung Electronics Co. Ltd.! [185 Taxman 3131 (Kar) is distinguishable. During the course of appeal proceedings before the CIT(A), the AO relied on the above mentioned case law. He submitted that the judgment of Karnataka High Court in the above mentioned case cannot be made applicable to the case of the assessee herein since it is distinguishable on facts. The AR relied on the observations of the CIT(Appeals) in Para Nos. 7.0 &7.1 at page Nos. 34 to 37 of his order. (g) Decision of Delhi High Court in the case of DClT vs. Infra Soft Ltd [2013] 39 Taxmann.com 88 (Delhi) is applicable. I. The Delhi High Court upheld the order of the Tribunal that amount received by the assessee under the license agreement for allowing the use of the software would not be royalty under the DTAA. 11. It held that what was transferred was neither the copy right in the software nor the use of the copy right in the software, but what was transferred was the right to use the copy righted material or article which was distinguishable from the rights in a copy right. Ill. It further held that the right that was transferred was not a right to use the copy right but was only limited to the right to use the copy righted material and the

13 13 same would not give rise to any royalty income and would be business income. IV. The Delhi High Court also expressed its disagreement with the decision of the High Court in the case of CIT vs. Samsung Electronics Co. Ltd., [2011] 203 Taxman 477 (Kar) that right to make a copy of the software and storing the same in the hard disk of the designated computer and taking backup would amount to copy right work. The AR submitted that the above decision of Delhi High Court is squarely applicable to the case of the respondent here in. (h) There is no taxable income accrued to the non-resident parties. The AR submitted that on account of the impugned transactions of the respondent here in with Infra Asia Trading PTE Ltd., Singapore and GAMMA Machinery and equipments PTE Ltd Singapore, no taxable income accrued to them and consequently there is no need to deduct tax at source u/s 195 of the I.T.Act, In this regard, the AR relied on the observations of the ClT(Appeals) in Para No. 5.0 at page Nos. 10 to 21 of his order. In the light of the above submissions, the AR prayed that the order of the CIT(A) may be upheld. 8. We have heard the arguments of both the parties, perused the record and have gone through the orders of the revenue authorities. The Assessing Officer held that the assessee company defaulted under the provisions of section 195(1) while making payment to foreign companies, namely i) Intra Asia Trading Pte Ltd. and Gamma Machinery and Equipments Pte Ltd., Singapore, for acquiring intellectual property rights and the smart card operating system software and, therefore, failure in violating the provisions of section

14 14 5(2)(b) read with section 9(1)(vi) or 9(1)(vii) of the IT Act, the assessee was liable to be treated as assessee in default as per section 201(1) of the Act. Accordingly, the ADIT determined the TDS liability u/s 201(1) and interest u/s 201(1A) for Intra Asia Trading Pte Ltd and for Gamma Machinery and Equipment Pte Ltd. Rs. 11,89,95,087/- and Rs. 68,17,077/-. The contention of the AR is that as the assessee does not have any patents or copy rights for the products purchased and it clearly indicates that the products are for the business purpose of the assessee and, therefore, would not come into the ambit of section 195(1) of the Act. The AR contended that the transactions effected by the assessee with foreign companies are in the light of various clauses embedded in the general agreement as well as supplementary agreement entered into by the assessee. The amounts paid by the assessee would constitute business income in the hands of foreign companies and, therefore, not liable for tax deduction at source u/s 195 of the IT Act. The CIT(A) after considering the submissions of the assessee and the ADIT thoroughly examined and discussed the issue in dispute with various case laws and gave a categorical finding that the appellant as well as the foreign companies acted on the agreements entered into by them. The appellant company made the outright purchase on their own account and those transactions were supported by proper documents such as invoices, shipping documents etc. Therefore he was of the view that improper analysation of the facts by the ADIT(IT) led him to an improper conclusion that in respect of a package transaction which is now under consideration the entire amount has to be considered either as royalty or fees for technical services. Thus, the ADIT(IT) missed the track from sum and substance of the transaction involving purchase of products under different agreements. In view of that, the supplementary agreement alone will make the foreign companies liable to tax for the purpose of Indian Income Tax Act, 1961 which consequently make the appellant liable u/s 195(1) for the payment made by it towards Intellectual Property Rights Source Code. On the

15 15 other hand, payments made for purchase of the software itself being covered as the sale of goods and hence the same cannot be subject to tax for the purchase of software which is outside the purview of taxation of withholding tax. 9. We find from the order of the ADIT u/s 201(1), that the ADIT agreed with the view of the assessee company that the payment under consideration constituted business income of the non-resident was valid considering the fact that the foreign companies were in the business of trading in the unique source code item held as stock in trade and in the absence of permanent establishment, there will not be taxable income accruing in India as per Articles 7 & 5 of Indo- Singapore DTAA. However, the ADIT observed that as the same consideration can be considered as royalties or fees for technical services as the case may be, the taxability of those items of income should be governed by the Article 12 of the DTAA. We are of the view that the transaction effected by the assessee would come into the ambit of Article 7 of the DTAA between India and Singapore, therefore, there is no need for the Assessing Officer to traverse beyond that article and examine the transaction in the light of Article 12. The article 7(1) & 7(5) of the DTAA with Singapore are as under: 7(1). The income or profit of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carried on business as aforesaid, the income or profits of the enterprise may be taxed in the other Contracting State but only on so much of such income or profits as is attributable to that permanent establishment. 7(5) For the purpose of this article, the term income or profits means income derived by an enterprise form the conduct of a trade or business; but does not include income derived by an enterprise in the form of rents, royalties, technical, services fee, interest, dividends, capital gains, fees for the management of the business of another enterprise, or remuneration or fee received by an enterprise for the furnishing to another enterprise of the services of its technical, skilled or other

16 16 personnel except where the property or other right giving rise to any such item of income is effectively connected with the permanent establishment of the enterprise. The term income or profits shall not also include income from the operation of ships or aircraft. 10. We have also gone through the Article 12 of the DTAA with Singapore stipulates as under: ROYALTIES AND FEES FOR TECHNICAL SERVICES 1. Royalties and fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such royalties and fees for technical sevices may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the recipient is the beneficial owner of the royalties or fees for technical services, the tax so charged shall not exceed: a. in the case of royalties referred to in paragraph 3(a) and fees for technical services as defined in this Article (other than services described in sub-paragraph (b) of this paragraph), 15 per cent. of the gross amount of the royalties and fees; b. in the case of royalties referred to in paragraph 3(b) and fees for technical services as defined in this Article that are ancillary and subsidiary to the enjoyment of property for which royalties under paragraph 3(b) are received, 10 per cent. of the gross amount of the royalties and fees. 3. The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use: a. any copyright of a literary, artistic or scientific work, including cinematograph film or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right, property or information; b. any industrial, commercial or scientific equipment, other than payments derived by an enterprise from activities described it! paragraph 4(b) or 4(c) of Article The term "fees for technical services" as used in this Article means payments of any kind to any person in consideration for services of a managerial, technical or consultancy nature (including the provision of such services through technical or other personnel) if such services:

17 17 a. are ancillary and subsidiary to the application or enjoyment of the right, property. or information for which a payment described in paragraph 3 is received; or b. make available technical knowledge, experience, skill, know-how or processes, which enables the person acquiring the services to apply the technology contained therein; or c. consist of the development and transfer of a technical plan or technical design, but excludes any service that does not enable the person acquiring the service to apply the technology contained therein. For the purposes of (b) and (c) above, the person acquiring the service shall be deemed to include an agent, nominee, or transferee of such person. 5. Notwithstanding paragraph 4, "fees for technical services" does not include payments: a. for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in paragraph 3(a); b. for services that are ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international traffic; c. for teaching in or by educational institutions; d. for services for the personal use of the individual or individuals making the payment; e. to an employee of the person making the payments or to any individual or firm of individuals (other than a company) for professional services as defined in Article 14; f. for services rendered in connection with an installation or structure used for the exploration or exploitation of natural resources referred to in paragraph 2(j) of Article 5; g. for services referred to in paragraphs 4 and 5 of Article The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties or fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties or fees for technical services arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right, property or contract in respect of which the royalties or fees for technical services are paid is effectively connected with such permanent establishment or fixed base. In such case, the provisions of Article 7 or Article 14, as the case may be, shall apply.

18 18 7. Royalties and fees for technical services shall be deemed to arise in a Contracting State when the payer is that State itself, a political subdivision, a local authority, a statutory body or a resident of that State. Where, however, the person paying the royalties or fees for technical services, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the liability to pay the royalties or fees for technical services was incurred, and such royalties or fees for technical services are borne by such permanent establishment or fixed base, then such royalties or fees for technical services shall be deemed to arise in the State in which the permanent establishment or fixed base is situated. 8. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of royalties or fees for technical services paid exceeds the amount which would have been paid in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Agreement Clause 1 of Article 12 lays down that royalty or fees for included services arising in a contracting State and paid to a residents of the other contracting State may be taxed in that other state. 11. Clause 2 of Article 12 lays down that royalty and fees for included services may also be taxed in a contracting State in which they arise. However, if the beneficial owner of the royalties or fees for included services paid to the residents of the other contracting State then the tax has been limited in percentage depending upon the number of years the convention has effect. 12. Clause 3 of Article 12 lays down that the term royalty means payment of any kind received as consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work..., including gains derived from the alienation of any such right, property or information. The term royalty has been defined by clause 3 of Article 12 as payment received for the use of, or the right to use any copyright.

19 The amount received by the Assessee company had been treated as royalty income by the AO on the basis of Explanation 2 to Section 9(1)(vi) of the Act holding that there was transfer of some rights (including the granting of a licence) in respect of the copyright. 14. What is thus required to be examined is whether income of the Assessee is royalty income as covered by Article 12 of the DTAA if not then the same would be taxable as business income as covered by the provisions of Article 7 of the DTAA. 15. To be taxable as royalty income covered by Article12 of the DTAA the income of the Assessee should have been generated by the "use of or the right to use of" any copyright. 16. The issue whether consideration for software was royalty came up for consideration before the Special Bench of the Tribunal in Delhi in the case of MOTOROLA INC VS DEPUTY CIT (2005) 147 TAXMAN 39 (DELHI). The Tribunal has held as under: 155. It appears to us from a close examination of the manner in which the case has proceeded before the Income-tax authorities and the arguments addressed before us that the crux of the issue is whether the payment is for a copyright or for a copyrighted article. If it is for copyright, it should be classified as royalty both under the Income-tax Act and under the DTAA and it would be taxable in the hands of the Assessee on that basis. If the payment is really for a copyrighted article, then it only represents the purchase price of the article and, therefore, cannot be considered as royalty either under the Act or under the DTAA. This issue really is the key to the entire controversy and we may now proceed to address this issue We must look into the meaning of the word "copyright" as given in the Copyright Act, Section 14of this Act defines "Copyright" as "the exclusive right subject to the provisions of this Act, to do or authorize the doing of any of the following acts in respect of a work or any substantial part thereof, namely: It is clear from the above definition that a computer programme mentioned in Clause (b) of the section has all the rights mentioned in Clause (a) and in addition also the right to sell or

20 20 give on commercial rental or offer for sale or for commercial rental any copy of the computer programme. This additional right was substituted w.e.f The difference between the earlier provision and the present one is not of any relevance. What is to be noted is that the right mentioned in Sub-clause (ii) of Clause (b) of Section 14is available only to the owner of the computer programme. It follows that if any of the cellular operators does not have any of the rights mentioned in Clauses (a) and (b) of Section 14, it would mean that it does not have any right in a copyright. In that case, the payment made by the cellular operator cannot be characterized as royalty either under the Income-tax Act or under the DTAA. The question, therefore, to be answered is whether any of the operators can exercise any of the rights mentioned in the above provisions with reference to the software supplied by the Assessee We may first look at the supply contract itself to find out what JTM, one of the cellular operators, can rightfully do with reference to the software. We may remind ourselves that JTM is taken as a representative of all the cellular operators and that it was common ground before us that all the contracts with the cellular operators are substantially the same. Clause 20.1 of the Agreement, under the title "License", says that JTM is granted a non-exclusive restricted license to use the software and documentation but only for its own operation and maintenance of the system and not otherwise. This clause appears to militate against the position, if it were a copyright, that the holder of the copyright can do anything with respect to the same in the public domain. What JTM is permitted to do is only to use the software for the purpose of its own operation and maintenance of the system. There is a clear bar on the software being used by JTM in the public domain or for the purpose of commercial exploitation Secondly, under the definition of "copyright" in Section 4 of the Copyright Act, the emphasis is that it is an exclusive right granted to the holder thereof. This condition is not satisfied in the case of JTM because the license granted to it by the Assessee is expressly stated in Clause 20.1 as a "non exclusive restricted license". This means that the supplier of the software, namely, the Assessee, can supply similar software to any number of cellular operators to which JTM can have no objection and further all the cellular operators can use the software only for the purpose of their own operation and maintenance of the system and not for any other purpose. The user of the software by the cellular operators in the public domain is totally prohibited, which is evident from the use of the words in Article 20.1 of the agreement, "restricted" and "not otherwise". Thus JTM has a very limited right so far as the use

21 21 of software is concerned. It needs no repetition to clarify that JTM has not been given any of the seven rights mentioned in Clause (a) of Section 14or the additional right mentioned in Sub-clause (ii) of Clause (b) of the section which relates to a computer programme and, therefore, what JTM or any other cellular operator has acquired under the agreement is not a copyright but is only a copyrighted article Clause 20.4 of the supply contract with JTM is as under: 20.4 In pursuance of the foregoing JT MOBILES shall: (a) not provide or make the Software or Documentation or any portions or aspects thereof (including any methods or concepts utilized or expressed therein) available to any person except to its employees on a "need to know" basis; (b) not make any copies of Software or Documentation or parts thereof, except for archival backup purposes; (c) when making permitted copies as aforesaid transfer to the copy/copies any copyright or other marking on the Software or Documentation. (d) Not use the Software or Documentation for any other purpose than permitted in this Article 20, Licence or sell or in any manner alienate or part with its possession. (e) Not use or transfer the Software and/or the Documentation outside India without the written consent of the Contractor and after having received necessary export or re-export permits from relevant authorities. This clause places stringent restrictions on the cellular operator so far as the use of software is concerned. It first says that the cellular operator cannot make the software or portions thereof available to any person except to its employees and even with regard to employees it has to be only on a "need to know basis" which means that even the employees are not to be told in all its aspects. What the Assessee can do is only to tell the particular employee what he has to know about the software for operational purposes. The cellular operator has been denied the right to make copies of the software or parts thereof except for archival backup purposes. This means that the cellular operator cannot make copies of the software for commercial purposes. This condition is plainly contrary to Section 14(a)(i) of the Copyright Act which permits the copyright holder to reproduce the work in any material form including the storing of it in any medium by electronic means. We may also notice Section 52(1)(aa) of the Copyright Act which lists out certain acts which cannot be considered as infringement of copyright. The particular clause

22 22 permits the making of copies or adaptation of a computer programme by the lawful possessor of the copy and the computer programme in order to utilize the public programme for the purpose for which it was supplied or to make backup copies purely as a temporary protection against loss, destruction or damage. Therefore, merely because the cellular operator has been permitted to take copies just for backup purposes, it cannot be said that it has acquired a copyright in the software Clause 20.4(c) makes it mandatory for the cellular operator, while making copies of the software for backup purposes, to also mark the copied software with copyright or other marking to show that the rights of the Assessee are reserved. This is one more indication that what the cellular operator acquired is not a copyright Clause 20.4(d) says that the cellular operator cannot use the software for any other purpose than what is permitted and shall not also license or sell or in any manner alienate or part with its possession. This has to be read with Clause 20.5 which says that the license can be transferred, but only when the GSM system itself is sold by the cellular operator to a third party. This in a way shows that the software is actually part of the hardware and it has no use or value independent of it. This restriction placed on the cellular operator (not to license or sell the software) runs counter to Section 14(b)(ii) of the Copyright Act which permits a copyright holder to sell or let out on commercial rental the computer programme. For this reason also it cannot be said that JTM or any cellular operator acquired a copyright in the software A conjoint reading of the terms of the supply contract and the provisions of the Copyright Act, 1957 clearly shows that the cellular operator cannot exploit the computer software commercially which is the very essence of a copyright. In other words a holder of a copyright is permitted to exploit the copyright commercially and if he is not permitted to do so then what he has acquired cannot be considered as a copyright. In that case, it can only be said that he has acquired a copyrighted article. A small example may clarify the position. The purchaser of a book on income-tax acquires only a copyrighted article. On the other hand, a recording company which has recorded a vocalist has acquired the copyright in the music rendered and is, therefore, permitted to exploit the recording commercially. In this case the music recording company has not merely acquired a copyrighted article in the form of a recording, but has actually acquired a copyright to reproduce the music and exploit the same commercially. In the present case what JTM or any other cellular operator has acquired under the supply contract is only

23 23 the copyrighted software, which is an article by itself and not any copyright therein We may now briefly deal with the objections of Mr. G.C. Sharma, the learned senior counsel for the Department. He contended that if a person owns a copyrighted article then he automatically has a right over the copyright also. With respect, this objection does not appear to us to be correct. Mr. Dastur filed an extract from Iyengar's Copyright Act (3rd Edition) edited by R.G. Chaturvedi. The following observations of the author are on the point: "(h) Copyright is distinct from the material object, copyrighted: It is an intangible incorporeal right in the nature of a privilege, quite independent of any material substance, such as a manuscript. The copyright owner may dispose of it on such terms as he may see fit. He has an individual right of exclusive enjoyment. The transfer of the manuscript does not, of itself, serve to transfer the copyright therein. The transfer of the ownership of a physical thing in which copyright exists gives to the purchaser the right to do with it (the physical thing) whatever he pleases, except the right to make copies and issue them to the public" (underline is ours). The above observations of the author show that one cannot have the copyright right without the copyrighted article but at the same time just because one has the copyrighted article, it does not follow that one has also the copyright in it. Mr. Sharma's objection cannot be accepted It is not necessary, therefore, to consider the alternative argument of Mr. Dastur, namely, that even assuming that the Department is right in saying that if you have the copyrighted article, you also have the copyright right therein, still it would mean that the copyright rights are transferred (acquired by JTM) and it would not be a case of merely giving the right to use and consequently Article 13 of the DTAA would not apply. Mr. Dastur, however, was fair enough to concede that if the Department is right in saying that if you have the copyrighted article, you also have the copyrighted rights, then Clause (v) of Explanation 2 below Section 9(1) of the Income-tax Act will apply because this clause ropes in "transfer of all or any rights" and is not restricted to "use" or "right to use", the copyright. However, he added that since the basic proposition of the Department has been demonstrated to be wrong, Clause (v) of Explanation 2 below Section 9(1) is not an impediment to accepting the assessee's contention.

24 We may also usefully refer to the Commentary on the OECD Model Convention (dated ) which is of persuasive value and which throws considerable light on the character of the transaction and the treatment to be given to the payments for tax purposes. Paragraph 14 of the Commentary, a copy of which was filed in Paper book No. V is relevant: COMMENTARY ON ARTICLE 12 - PAPER BOOK V "14. In other types of transactions, the rights acquired in relation to the copyright are limited to those necessary to enable the user to operate the program, for example, where the transferee is granted limited rights to reproduce the program. This would be the common situation in transactions for the acquisition of a program copy. The rights transferred in these cases are specific to the nature of computer programs. They allow the user to copy the program, for example onto the user's computer hard drive or for archival purposes. In this context, it is important to note that the protection afforded in relation to computer programs under copyright law may differ from country to country. In some countries the act of copying the program onto the hard drive or random access memory of a computer would, without a license, constitute a breach of copyright. However, the copyright laws of many countries automatically grant this right to the owner of software which incorporates a computer program. Regardless of whether this right is granted under law or under a license agreement with the copyright holder, copying the program onto the computer's hard drive or random access memory or making an archival copy is an essential step in utilizing the program. Therefore, rights in relation to these acts of copying, where they do no more than enable the effective operation of the program by the user, should be disregarded in analyzing the character of the transaction for tax purposes. Payments in these types of transactions would be dealt with as commercial income in accordance with Article 7." 166. We may also usefully refer to the proposed amendments to the regulations of the Internal Revenue Service (IRS) in the USA. Again these regulations may not be binding on us but they have a persuasive value and throw light on the question before us, namely the difference between a copyright right and a copyrighted article. These regulations have been placed at pages 136 to 157 of Paper book No. II. The actual regulations as well as the explanatory Note explaining the object and the purpose of the proposed regulations have also been given. In paragraph 1 of the Note titled "Background", it has been stated that the proposed regulations require that a transaction involving a computer programme may be treated as being one of the four possible categories. Two such categories are the